An example of the going concern principle
One of the fundamental accounting concepts is that of going concern. In simple terms, this typically means a business is unlikely to be able to continue in operation for the next 12 months.
It is not very often the examples come to light, but recently in Ireland we had one. The national football association, the Football Association of Ireland, has their auditors state the organisation could not be deemed a going concern. According to the RTÉ news website, the auditors noted:
“While the company has received some advanced funding from UEFA during 2019 to enable the company to meet some of its current liabilities there is not sufficient audit evidence that the company will be able to meet its liabilities as they fall due. Therefore we are unable to obtain sufficient audit evidence to support the assumption that the company will continue as a going concern.”
The piece also notes the levels of debt and losses over several years. The statement above provides a nice clear understanding of what going concern means. Do have a read of the RTÉ article and other coverage to get more insights on the association.
Getting paid – it’s a must for any organisation, even the HSE
The Health Service Executive (HSE) is responsible for Ireland’s public health service. It has been the subject to criticism over the years for being inefficient and it is one of the largest items of public expenditure.
Thankfully, I have not been a frequent user of HSE services – that is, I have been generally healthy. My son had a mild concussion recently, so we had to attend the A &E department in our local hospital. On attending A & E, every patient is charged €100. The idea of this fee is two-fold 1) to stop the use of A & E by people with non-urgent issues and 2) to help reduce budgetary cost pressures. Both of these are fine in my view.
So, good law-abiding citizens as we are, we asked to pay as we entered. We were told “come back when you leave”. So we did, and were told “we’ll post the invoice”. So now, reflecting on this as an accountant, that’s two opportunities missed to collect payment. Then we get the invoice. There is no bank account details on it, and I cannot pay online. I have to call a number which was always busy. I could pay at a Post Office – fine if I am not working or have one close to work – I do work and I don’t have one close. Eventually we paid! If I do a quick media search I can find one hospital owed €600,000, and some reports from a few years back suggest the HSE are owed €200m . Apparently, people who do not pay are pursued, but how much does this cost? A lot more than the amount collected perhaps, which is not good for a cost stretched organisation.
To me, the process of payment should be much easier. Twice we asked at the hospital. I did not check if they had a credit card machine there, but why would they not. Why can I not pay online or to a bank account, or by PayPal? I shared my story with some friends, and they tell me some hospitals accept online payment. This made me even more annoyed, not even a common system! The lesson here is, and it applies to all businesses and organisations, you have to collect monies owed. The first thing then is to make it easy to pay, and to me the HSE fails badly in this regard.
Break even in farming
Farmer’s, even if they know their costs, face a problem in that they can’t do anything about crop prices. If the price is above break even, it may even make sense to rent more land to grow more.
And of course, if a farmer knows the break even ‘cost’ per acre/hectare then they can try to get the best price above that.
Here is a good article showing the costs of corn this year, and working out a break even price. It’s a good example of the application of break even analysis.
Liquidity ratios – 3 in series of 6 on financial ratios
Your have probably heard the terms liquidity and solvency. Liquidity refers to the ability to convert assets to cash. For example, inventories may be more liquid (i.e. can be sold for cash quicker) than a non-current asset like a building. Solvency refers to the ability of a business to pay debts as they fall due. Liquidity and solvency are closely related concepts. If assets cannot be converted to cash, debts like loan repayments or payments to suppliers may not be met. To be unable to pay debts as they fall due means a business is insolvent, which can mean business failure. There are two useful ratios to help us assess the state of a businesses’ liquidity – the current ratio and the quick (or acid-test) ratio. The current ratio is:
Current ratio: Current assets
Current liabilities
The basic idea the current ratio is that for a company to be able to pay its debts as they fall due, current assets should cover current liabilities by a multiple. Generally a current ratio of at least 2:1 is good. This means that current assets are twice current liabilities. So, even if some stock could not be sold or some trade receivables not paid, current liabilities would still be covered for payment. However, the 2:1 figure is only a guideline. If we calculate the current ratio for Diageo plc for 2010 (from the statement of financial position on p. 108), we get:
6,952/3,944 = 1.76 : 1.
Although not 2:1, it should not be a major problem. Think about the type of business and the inventory it has – can you imagine Diageo having difficulty selling it’s stock of Guinness for example.
The Liquid ratio, and it is calculated as follows:
Liquid ratio: Current assets – inventory
Current liabilities
This ratio is also called the Quick ratio or the Acid Test ratio. It is very similar to the Current ratio, except that inventory is deducted from current assets. This is because inventory is typically regarded as being the least liquid current asset. Often the yardstick for the Liquidity ratio is 1:1, but this depends on the type of business. For example, large retailers may have relatively low stock and almost no receivables, which will skew the figure well below zero if we assume suppliers give credit.
If we calculate the current ratio for Diageo plc for 2010 (from the statement of financial position on p. 108), we get:
6,952-3,281/3,944 = 1.12 : 1
The Current and Liquid ratios serve as useful indicators of the liquidity/solvency or a business. However, as with other ratios, the trend over time is important. Any business may face short-term liquidity problems which could skew either of the above ratios. Short-term liquidity problems may arise if, for example, customers are slow to pay or inventories can’t be sold. Such problems are normally overcome through the management of inventory and receivables, which I’ll deal with in the next post.
(Image above from withfriendship.com)
Controlling your cash flow
I’m in holidays at the moment, so I am taking a short cut by referring to another blog! SmallBusinessCan is a website set up by an Irish bank and other sponsors to help small business by giving practical advice through its network of users and sponsors and through regular postings. Here is a recent post from the websites blog. Controlling your cash flow provides 15 suggestions to help control your cash flow.
Don’t loose sight of profits and cash flows – how Lego revived its outlook
The Danish toy company Lego, has had to do a bit of re-building of late, according to Time (June 7th, 2010). Lego has been around since 1932 and has given many generations endless hours of fun (or peace if your a parent!). The product was created by an unemployed Danish carpenter (Ole Kirk Christiansen) and he patented it in 1958. Today, as anyone with kids knows, there are so many high-tech toys that compete with traditional toys like Lego, which has education and learning at its heart. This in fact was one of the contributors to Lego making large losses (e.g. $450 million in 2004) – focusing too much on the educational value of its 14,000 unique stock items. In 2004, a new CEO Jorgen Knudstorp, took the helm. He quickly reinvigorated the company by not forgetting one of the basic lessons of accounting and managing a business – the bottom line counts. There were lay-offs, plant closures and new licensing deals (Star Wars, Harry Potter for example) and some efforts to adapt the product to the digital age e.g. an online website where children can design their own creation and order a physical copy. The result – profits were $440 million in 2009. So don’t forget, now matter how good your product or service is, it can only survive if the bottom line is positive and generating cash!Small business cash flow – a week from a business owners’ diary
One of the most common issues in small business today is cash flow. As sales decrease and consumers have less cash, smaller businesses are finding it difficult to get paid in some cases. I have spoken to 3 or 4 small business owners here (in Ireland) in the past week or so and while they are all “ticking over”, they all recounted difficulties in getting paid – none are cash only businesses. Some are sailing quite close to the wind with their bank overdrafts. Trying to live within the overdraft limit can become a daily task. And of course, it’s a viscous circle and both suppliers and customers are often experiencing similar cash flow issues.
To relate the kind of problems businesses are facing, and maybe you’ll get some help here, read the 5 blog posts by Paul Downs in the NYTimes. He has a small cabinet making business in Pennsylvania. Yes, ok it’s a US example, but the problems are the same as those in Ireland and elsewhere in Europe at the moment. Here’s a link to the first post from a week in Paul’s business.
My Week in Cash Flow: Monday – You’re the Boss Blog – NYTimes.com.
Links to the other four posts follow on from the above link.
Martin's accounting blog 